An American Perspective from China

There’s a Bubble in the Boonies Too

One of the big debates among China real estate watchers is whether the country’s apparent property bubble — characterized by soaring purchase prices, low occupancy rates, and slumping rents — is restricted soley to premier cities like Beijing and Shanghai, or extends to 2nd and 3rd tier cities as well. I’ve heard experts insist that it’s purely a top-tier phenomenon, but the evidence of my eyes and ears tells me that similar market dynamics have taking hold all across China. An article earlier this week in the Los Angeles Times provides some evidence that I’m right.

I’m briefly quoted in the article, mentioning how dependent local governments have become on property sales as a source of revenue (up to 40%, according to one central government study), which gives them every incentive to keep markets bubbling. But my little tidbit aside, the article is well worth reading for its account of conditions in Hefei, a 3rd tier city that serves as the capital of Anhui province.

When the author, Beijing-based reporter David Pierson, first called me up and asked about real estate speculation in 2nd and 3rd tier cities, Hefei was one of the first names off the tip of my tongue. Before 1949, Hefei was a small market town, and even just a couple years ago, it was a pretty dusty, unassuming place. Anhui province belongs to what I call (in my Nine Nations of China framework) The Crossroads, a largely rural region along the middle Yangtze River that supplies many of China’s migrant workers. I’ve spent some time in Hefei on business, and I’ve been astounded at the colossal amount of property development taking place around its airport. While impressive in both scale and grandiosity, it just didn’t make sense to me given the city’s economy and income level, and the experience was actually one of the first that got me thinking seriously about the prospect of a real estate bubble in China.

It just so happened that David had just returned from Hefei, and that the frenetic real estate market there formed the basis for his story. Noting that average housing prices in Hefei soared 50% last year, he describes the scene:

While pricey by local standards, [prices at $120,000 per apartment are] still a fraction of what homes cost in the capital. That’s why buyers continue to pour in from across the region, accumulating apartments as a hedge against inflation in a nation where there are few investment alternatives. More residential units were sold here the first three months of 2010 than in Beijing or Shanghai — cities four times the size of Hefei . . .

About 15% of the city’s residents are now estimated to be construction workers . . . One of the most popular radio programs here is an afternoon talk show called “Blossom Real Estate.” Some prospective buyers get half a dozen text messages a day on their cellphones from developers advertising new properties . . . “Everyone in Hefei lives with the real estate industry,” said Guo Hongbing, a marketing consultant for several developers. “You can’t escape it.”

Note several familiar trends I’ve been mentioning all along: people buying multiple apartments they have no intention of occupying; up-front cash purchases; funds channeled into real estate due to lack of investment alternatives; a property market that far outstrips the local economy in size and energy; reliance on construction as a job-generator; and buyer psychology approaching obsession. In particular, David observes the same empty apartments that caught my attention in the first place:

All the properties had been sold, and Guo was interested in estimating how many were left empty by investors. His unscientific method? Looking for curtains.

“See, less than half that building is occupied,” he said, pointing to one block with several bare windows. “These speculators want to buy as many as possible.”

So is China’s property bubble limited to Beijing and Shanghai? One Chinese economist weighs in:

“The situation in Hefei is a symbol of the craziness in China’s real estate market,” said Cao Jianhai, a professor of economics at the Chinese Academy of Social Sciences, a government think tank. “Prices in second- and third-tier cities are increasing more dramatically than in the first tier. It’s very dangerous, and it puts local banks at risk.”

For those who are interested in my take on the Chinese government’s efforts to cool down all this excitement, and whether they will prove effective or not, you may want to check out this syndicated AFP article that quoted me earlier this week. One of the government’s main objectives, I note, is simply to signal its intent:

“The government is sending out signals that it is not going to keep this party going and that has made people more cautious,” said Patrick Chovanec, an economics professor at Tsinghua University.

But in a comment that didn’t make it into the article, I worried that while investors are getting jittery about prominent markets like Beijing and Shanghai, rather than exiting real estate altogether, they may just be shifting their focus to 2nd and 3rd tier cities. As for the practical effect of some of the government’s more piecemeal measures (such as requiring higher down-payments on mortgages), I have my doubts:

Chovanec warned the measures aimed at curbing speculative activity could miss their target because about 50 percent of residential purchases were paid for in cash.

“Most of the people paying cash are buying their second, third, fourth or fifth unit to hold idle as a place to stash their cash,” he said.

A holding tax on vacant properties and increased investment options for Chinese people would be more effective in curbing prices, Chovanec said.

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A thought provoking article. The degree of speculative frenzy is certainly scary. Am trying to figure out what and how a burst will actually occur.

In one sense, property seems to be soaking up the high rate of savings which was primarily stashed in the banking system that is state owned with negligible returns and isn’t always deployed all that wisely in terms of lending. The question I am pondering is how long will people hold empty non-productive assets before finding a need or desire to sell in soft to non-existent market to free up cash given the lack of alternative investment options.

I am sure I am missing something here, but I am always amazed at how property owners here would rather sit on a empty non-productive asset rather than rent out and at least get some form of return while holding out for an imagined greater appreciation, and all the while the property is deteriorating due to a total disregard for spending minimal amounts on maintenance.

I’m wondering how can the government defuse this bubble slowly? Since people are using property as a store of value (like gold) and not for ‘rational’ investment or living prices can fall dramatically.

I wonder if the announcement of annual property taxes will get the herd stampeding out of properties.

While 50% of the units were purchased with cash, a lot of them were borrowed cash. Some entrepreneurs tell the banks they will use the money for their company operations, but instead they use the cash to speculate properties. It’s hard to quantify, but I hear this is quite normal. China’s problem lies in wealth distribution, tax collection from rich people are very ineffective due to lack of law, lack of law enforcement and ubiquitous corruption. It’s hard to imagine the current government measures will have much more effect than psychological impact, but sometimes, economy is all about animal spirit. If the housing bubble bursts, China needs to devalue its currency.

I lived in Kaifeng, Henan Province, a good example of a third-tier Yellow Land city for the past three years. In a city with a population of about a half million and very little industry to speak of, I was continually shocked by the number of condos going up around the city. Kaifeng, is still replete with over-capacity in terms of both comerical and residential property. The fact which distressed me the most was that many of these unoccupied buildings were in such disrepair. They seemed to be falling down before they had ever had the chance to become occupied. Regarding people’s investing in such property, I have a hard time seeing that such an investment will last for very long.